Todd Peters: A mentor of mine, a gentleman named Bert White – he’s now a managing director of LPL in their research department – he kind of coined a phrase or kind of a thought process of operating infrastructure, repeatability of process and survivability. Now when we were working through some events, it was more of management team leaves one firm and joins another firm, but the thought process to me is actually is much more applicable to a firm starting out. You have to figure out how to create an operational infrastructure that supports your business. You then have to make sure that whatever inputs you had to make your investment decisions are available to you in your firm, your startup firm, so that you can repeat the process that you had been doing prior and then the survivability is how long can we make it without winning any business because sometimes it may take you two or three years before you start seeing the assets coming through if your track record is what you hope it’s going to be.
From what we have seen at the startup level is everyone thinks ‘if I build it, they will come’ mentality, which is no longer the case. You could have the greatest track record in the world, but if no one knows about it, you’re not going to get any money. You see this overly optimistic thought that the money is just going to flow into me as soon as I open the door. Emerging managers really need to think of, “The first three years, I’m going to get nothing. No assets at all. Can I make it three years?” You have to make sure you have either saved yourself or you have found a partner that can give you that startup capital in the way Dave said, though, with the opportunity to buy it back over time, but people need to realize that just because you’re great doesn’t mean the money is going to flow over and certainly not to the level that you expect.
I’ve also seen equally not only optimism that the assets are going to flow over, but that they would be able to support a huge team of people already. They may bring all of their investment team at another firm and all of a sudden they become top heavy and so they don’t focus on expense management. As I said, these folks may be critical of the expense management of the companies they’re looking at, but they need to be as critical. I see very few companies actually understanding that we need to keep expenses down, but not lose quality, so they don’t think through how to properly manage that. Then they ultimately determine that they don’t need to worry about compliance, they don’t need to worry about the infrastructure that it takes to run the business. They don’t feel like putting time into all of the things that make the organization run from accounting to legal to custodial to technology. Everything in that part, they just don’t feel like messing with because it’s not what they want to do and we have found that the majority of problems at a manager are not performance-related. It is a regulatory hiccup, an infraction that was missed because they just didn’t put their time and attention.
We have found most clients, at least for a period of time, will work through poor performance. The SEC writes you a letter, allocators just can’t stay. They just can’t stay and most of the time, the SEC letters don’t come from poor performance. It comes from not managing the internal infrastructure. From where we’ve sat on doing the work we have, people don’t think of survivability, so they don’t set aside enough capital in the beginning. They don’t focus on expense management in the beginning. They target the wrong type of client, so they end up with no success at all rather than really kind of finding the right kind of client to start with and then they determine that they just don’t want to mess with any of the compliance or regulatory infrastructure that’s required now and they’ll end up having some major infraction that trips them up before they even get a chance.
David Yazdan: I would echo what Todd said about having patience and being ready to be irrelevant for a while, as I think Seth Klarman said. Seth Klarman was irrelevant for a very long time until he wasn’t. I think when you look at the trajectory of asset flows and this is if you’re doing everything right, it tends to happen in that fifth, sixth, seventh year or beyond and you almost want it to happen then because you’re showing a commitment to the allocators and whether it’s an endowment or it’s a multifamily office, they want to get to know you. They want to know how you’re going to invest, they want to be sure you’re going to be sticking around for the next ten years, twenty years and that doesn’t happen in one meeting. It doesn’t happen in two or three meetings and sometimes it happens over a multiyear period, but I would say the managers that get that type of asset have sticky assets.
These are folks that may take a while to allocate, but they stay because they did their work and it’s almost like the agony of defeat for them to pull money from a manager because it essentially tells them that they did a bad job doing the research in the first place. Patience is needed, a commitment to the process. A lot of these manager hate marketing. You’ve got to market. It’s not a salesmanship, showbiz type thing. It’s a showman of commitment and that you’re in this thing for the long-term and we want you as a partner. Really, the only way to do that is through exposure, accessibility. You have to think about your letters, you have to think about the presentation book. You have to potentially think about public relations, if that’s the way you want to go because that could be helpful depending on the audience you want to be marketing to. Those are things that I would add to Todd’s comments about that.
Peters: I think one thing that managers I don’t know if they understand, some do, but when a manager is talking to an allocator, the CIO of a family office or a multifamily office or an endowment, that’s when their reputation and their necks are on the line, so the manager’s reputation’s on the line when they make an investment in a company. The allocator’s reputation is on the line when they’re picking a manager and it goes to what Dave was saying about career risk. Managers that take the time to make sure that that allocator truly understands what that portfolio is about, what they’re about, how they do their business is going to make that allocator more comfortable to put their neck on the line and that takes time and that takes focus and that takes effort and that takes doing exactly what Dave said, creating that communication line.
Tying back to your limiting capacity, when a manager isn’t trying to be all things to all people, they can give more access to the partners that they want, that helps to build that, but that takes time. Knowing that when they start their firm it could…hopefully not. Hopefully, they open Day 1 and get the assets they want, but going in with the idea that this could be a tough road, but a very fruitful one if they take the time and effort to do it, it can work. The one thing I would go back to is when any manager is thinking about doing this, think about operational infrastructure, repeatability of process and survivability. If they can answer those three things, then they’re going to have a good shot of making the transition to a long-life manager, not just an emerging one.